Why did Xcel's reported EPS fall so sharply in 2004 if continuing-operations earnings were flat?

Continuing-operations diluted EPS was $1.27 in both 2003 and 2004, but total GAAP diluted EPS dropped from $1.50 to $0.87. The gap comes from discontinued operations, which lost $0.40 per share in 2004 versus earning $0.23 in 2003. The main driver was a $143 million after-tax impairment on the planned sale of Seren Innovations, a broadband subsidiary. The 2003 results had included large NRG-related tax benefits and equity reversals that do not recur.

How significant is the COLI tax dispute, and what is the potential earnings impact?

The IRS has disallowed interest deductions on corporate-owned life insurance policy loans for tax years 1993 through 1999. If the IRS prevails, tax and interest through December 31, 2004 would reduce earnings by an estimated $311 million, or about $368 million including penalties the IRS has said it will seek. Management estimates annual 2005 after-tax earnings would fall by about $40 million (9 cents per share) if the deductions were no longer available. Xcel has filed suits in federal district and tax court and has not recorded a provision, so the outcome could be material and would likely take several years to resolve.

Can Xcel's utilities earn their authorized returns, and what rate relief is pending?

Management acknowledges that it is not currently earning its authorized ROE in most states where it operates regulated utilities. Pending requests include a roughly $10 million Minnesota gas rate increase with an 11.5% requested ROE (decision expected mid-2005), a North Dakota gas case, a FERC transmission increase of about $5 million, a Minnesota electric rate case planned for late 2005 with rates in 2006, and a Colorado electric case planned for 2006. Rate relief is not guaranteed, and the timing and amounts approved by regulators will largely determine whether earnings improve as the capital program grows.

How will Xcel fund its large capital program and is the balance sheet strong enough?

Capital requirements are about $1.5 billion in 2005, $2.3 billion in 2006 and $1.8 billion in 2007, including debt maturities. Xcel expects to rely mainly on internally generated cash and to issue short- and long-term debt and equity as needed. Its common equity ratio is about 42% against a 30% SEC condition. Holding-company debt is rated Baa1 by Moody's and BBB- by S&P, which is the lowest investment-grade level at S&P. Access to capital at reasonable cost depends on maintaining those ratings and on SEC approval of the pending financing authority extension.

What is the outlook for the dividend and the nonregulated businesses?

The quarterly dividend was raised to $0.2075 per share in May 2004, and management says its dividend policy is sustainable and aims to grow dividends in line with long-term earnings growth of 2% to 4%. PUHCA limits dividends to retained earnings, which stood at $397 million at year-end 2004, and holding-company financing costs weigh on results. Nonregulated exits are largely complete: UE is being sold to Zachry Group (expected April 2005), Cheyenne was sold in January 2005, and Seren is expected to be sold by mid-2005. Management does not expect material new nonregulated investments.

XEL/XELLL 10-K FY2004 Annual Report — Revenue, Net Income, EPS

01—Abstract

Summary

Summary of the 10-K filed March 4, 2005. Cited figures are marked; the original filing is the authoritative source.

Xcel Energy's FY2004 10-K shows a regulated utility franchise under pressure from earnings quality issues and a large legacy liability.

Earnings from continuing operations were flat at $1.27^a diluted EPS (vs. $1.27 in 2003), while total GAAP diluted EPS fell to $0.87 from $1.50, driven mainly by a $143 million after-tax impairment on the planned sale of Seren Innovations and the $752 million NRG settlement payment made in 2004. The company is also exiting nonregulated businesses (UE sale agreed March 2005, Seren pending, Cheyenne sold January 2005), so the investment case increasingly rests on the regulated electric and gas utilities. Management frames 2004 as a year of weather-related headwinds (8 cents per share), legal settlement costs, and regulatory accruals, while stating that the company is currently not earning its authorized ROE in most jurisdictions and must file multiple rate cases in 2005 and 2006.

The capital plan is large and rising. Utility capital expenditures are projected at $1.24 billion^b in 2005, $1.50 billion in 2006 and $1.50 billion in 2007, anchored by the roughly $1 billion MERP emissions project in Minnesota and the Comanche 3 coal unit in Colorado (about $1.35 billion total, of which Xcel's share is about $1 billion). Funding will rely mainly on internally generated cash plus debt and equity issuance under SEC PUHCA authority, which the company has requested to extend through 2008.

Balance-sheet metrics look adequate but not strong: the holding-company credit ratings are Baa1 (Moody's) and BBB- (S&P), and the common equity ratio is about 42% against a 30% PUHCA floor. Key contingencies include a potential $311 million (up to $368 million^c with penalties) COLI interest-deduction exposure, a pending FERC market-based rate review, MISO Day 2 market implementation uncertainty, and nuclear waste litigation.

For investors, the central questions are whether the utilities can secure the rate increases needed to earn authorized returns on a rising capital base, whether dividends (raised to $0.2075^d quarterly in 2004) remain covered as the balance sheet absorbs the NRG payment and the capital program, and how the COLI dispute and regulatory outcomes resolve. Earnings guidance for 2005 is $1.18 to $1.28 per diluted share from continuing operations.

02—Key points

Key Highlights

Diluted GAAP EPS fell to $0.87 in 2004 from $1.50 in 2003, while continuing-operations EPS was flat at $1.27; the decline reflects a $143 million after-tax Seren impairment and discontinued-operations losses.
A $752 million settlement payment to NRG in 2004 drove a $580 million year-over-year drop in operating cash flow from discontinued operations; total operating cash flow fell to $817 million from $1.38 billion.
Management states Xcel is currently not earning its authorized return on equity in most of its regulated jurisdictions and plans rate filings in Minnesota (electric, late 2005), North Dakota and Minnesota (gas), Wisconsin (2005) and Colorado (2006).
Capital expenditure forecast of $1.24 billion (2005), $1.50 billion (2006) and $1.50 billion (2007), centered on the roughly $1 billion MERP project and Comanche 3 coal plant.
Potential COLI interest-deduction exposure of $311 million in tax and interest (about $368 million with penalties) through 2004, with about $40 million of annual after-tax earnings at stake (9 cents per share) if the deductions are disallowed.
2005 EPS guidance of $1.18 to $1.28 per diluted share from continuing operations, assuming normal weather, 2.0% to 2.4% retail electric sales growth and a $30 million to $55 million decline in trading and short-term wholesale margins.
Credit ratings are Baa1/BBB- at the holding company, with a 42% common equity ratio versus a 30% PUHCA requirement; the company has requested SEC financing authority through June 2008 for up to $2.0 billion of new securities.

03—Questions

Frequently Asked Questions

Why did Xcel's reported EPS fall so sharply in 2004 if continuing-operations earnings were flat?
Continuing-operations diluted EPS was $1.27 in both 2003 and 2004, but total GAAP diluted EPS dropped from $1.50 to $0.87. The gap comes from discontinued operations, which lost $0.40 per share in 2004 versus earning $0.23 in 2003. The main driver was a $143 million after-tax impairment on the planned sale of Seren Innovations, a broadband subsidiary. The 2003 results had included large NRG-related tax benefits and equity reversals that do not recur.
How significant is the COLI tax dispute, and what is the potential earnings impact?
The IRS has disallowed interest deductions on corporate-owned life insurance policy loans for tax years 1993 through 1999. If the IRS prevails, tax and interest through December 31, 2004 would reduce earnings by an estimated $311 million, or about $368 million including penalties the IRS has said it will seek. Management estimates annual 2005 after-tax earnings would fall by about $40 million (9 cents per share) if the deductions were no longer available. Xcel has filed suits in federal district and tax court and has not recorded a provision, so the outcome could be material and would likely take several years to resolve.
Can Xcel's utilities earn their authorized returns, and what rate relief is pending?
Management acknowledges that it is not currently earning its authorized ROE in most states where it operates regulated utilities. Pending requests include a roughly $10 million Minnesota gas rate increase with an 11.5% requested ROE (decision expected mid-2005), a North Dakota gas case, a FERC transmission increase of about $5 million, a Minnesota electric rate case planned for late 2005 with rates in 2006, and a Colorado electric case planned for 2006. Rate relief is not guaranteed, and the timing and amounts approved by regulators will largely determine whether earnings improve as the capital program grows.
How will Xcel fund its large capital program and is the balance sheet strong enough?
Capital requirements are about $1.5 billion in 2005, $2.3 billion in 2006 and $1.8 billion in 2007, including debt maturities. Xcel expects to rely mainly on internally generated cash and to issue short- and long-term debt and equity as needed. Its common equity ratio is about 42% against a 30% SEC condition. Holding-company debt is rated Baa1 by Moody's and BBB- by S&P, which is the lowest investment-grade level at S&P. Access to capital at reasonable cost depends on maintaining those ratings and on SEC approval of the pending financing authority extension.
What is the outlook for the dividend and the nonregulated businesses?
The quarterly dividend was raised to $0.2075 per share in May 2004, and management says its dividend policy is sustainable and aims to grow dividends in line with long-term earnings growth of 2% to 4%. PUHCA limits dividends to retained earnings, which stood at $397 million at year-end 2004, and holding-company financing costs weigh on results. Nonregulated exits are largely complete: UE is being sold to Zachry Group (expected April 2005), Cheyenne was sold in January 2005, and Seren is expected to be sold by mid-2005. Management does not expect material new nonregulated investments.

04—Continue

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